Politics 101

America’s First Tax was a 25% Excise Tax on American Whiskey made from Corn

Thomas Jefferson held a dinner party where he, Alexander Hamilton and James Madison met to resolve some issues. Hamilton was stressed out. He was facing strong opposition for his assumption plan. Secretary of the Treasury Hamilton wanted to assume all the states’ debts and lump them into the federal debt. To get the nation’s finances in order. Establish good credit. And raise revenue for the new nation. The Virginians, Jefferson and Madison, offered their assistance if Hamilton would give them the nation’s capital. Hamilton got his assumption. And the Virginians got the nation’s new capital on the Potomac River. Across from Virginia. Where they could keep a close eye on the nation’s business. And everyone lived happily ever after.

Well, not exactly. There was already growing discontent across the land. Hamilton understood business and commerce. And banking. Farmers don’t like bankers. Or commerce. Or business. Many in the south and on the frontier worked the land. As yeoman farmers. Families working small farms that they owned. They believed, as Jefferson believed, that the most honorable work in America was farming. And that America’s future was the growth of farming. Small farms. Owned by families working the land. Yeoman farmers. Proud. Pure. And wholly American. This despite Jefferson being a member of the slave-owning planter elite. Who indulged in little physical labor.

So the south and the frontier were no Hamilton supporters. They didn’t like his high finance ideas for the new nation. And they especially didn’t like his whiskey tax. A tax of 25% on western corn products. Which you made whiskey from. The new American alcoholic beverage of choice after they eschewed beer. The beverage of choice before the rebellion. When they were all content British citizens. But an excise tax on corn products was little different from the excise taxes that caused the colonies to rebel against Great Britain in the first place. Sure, there was one subtle difference this time. The whiskey tax was taxation with representation. And, technically speaking, legal. But on corn? The new tax seemed to fall unfairly on the West. Which had a corn economy. And used the whiskey they made from it for money. So these frontier people were not just going to sit idly by and take this new taxation without a fight.

The Washington Administration took Decisive Action in Suppressing the Whiskey Rebellion

This first tax was to help finance Hamilton’s assumption. But it was more important than the revenue it would raise. The whiskey tax was a matter of principle. It was probably poor policy. And probably not the smartest thing to do. Picking a fight with the toughest and most fiercely independent people in the country. Frontier people. Who lived off the land without any of the city comforts enjoyed back east. But the tax was the law. And the first test of the new nation. If the government retreated in the face of opposition to a law passed by Congress their experiment in self-government would fail. For as unpleasant as taxation was it was the reason they formed a new nation in 1787. To levy taxes so they could pay their past debt. And their current bills. So President Washington and Hamilton hunkered down on the tax.

And the riots came. The Whiskey Rebellion. Around Pittsburg. Kentucky (aka bourbon country). The backcountry of the Carolinas. And elsewhere. They refused to pay the tax. And attacked the tax collecting apparatus. Even the courts. It was war. The spirit of ’76 was alive again. Protesting a distant central power trying to impose a tax on them. Washington offered amnesty if they just dispersed and went home. They refused. So Washington raised an army of some 13,000 strong. Larger than any army he commanded during the Revolutionary War. And led the army west with Hamilton to meet the insurrection. The first and only time a sitting president led an army. As the army approached resistance melted away. So Washington handed command over to Henry “Lighthorse Harry” Lee (a Revolutionary War veteran and hero) and returned to the capital in Philadelphia. Hamilton remained with the army. As the army arrived the insurrection collapsed. The army caught some rebels and tried them. And two received death sentences. Who Washington later pardoned.

Score one for the rule of law. Washington was pleased with the outcome. Hamilton, too. They took decisive action to subdue an insurrection. The people in general were happy that they restored peace. And that the country didn’t collapse into anarchy. All in all a win-win for the people and the government. Almost. Not everyone saw it in this light. Some saw a king leading an army against his own people. A professional army. Little different from British redcoats. Or Oliver Cromwell’s New Model Army a century or so earlier. A professional standing army squashing those who disagreed with the government. And Jefferson did not like it. Nor did a lot of those in the south. Or on the frontier.

President Washington issued a Proclamation of Neutrality in the New War between Great Britain and France

Seeing Hamilton ride at the head of an army only reinforced Jefferson’s opinion of him. A power-hungry, British-loving puppet master. And the puppet was President Washington. The dislike between Hamilton and Jefferson turned into outright hostility. They had two different visions of America. And these two visions were mutually exclusive. Cabinet meetings became insufferable as Hamilton and Jefferson constantly fought. And the French Revolution didn’t help matters any. The radical Jefferson supported the radical French. Who he knew and sat with in the Jacobin clubs while he was in France. Jefferson was all for overthrowing monarchies. So when the French and British declared war on each other it was a no brainer who to support for Jefferson. Vive la France!

Of course there was only one problem with that position. About 75% of U.S. exports went to Great Britain. Even more of her imports (approximately 90%) came from Great Britain. And then there was the Royal Navy (RN). Who still ruled the high seas. And all the international trade routes. In addition to the RN there was the British Army. Who still occupied forts on the American western frontier. And who were still in contact with their Indian allies from the Revolutionary War. Couple this with the fact that the U.S. had no comparable army or navy. And was already having trouble on the frontier with the Indians (from the influx of settlers into the western territories). So siding with France against Britain was not the smart move. Yes, the French were instrumental in helping the Americans achieve their independence from Great Britain. But America was a country emerging from 8 years of war that just had to suppress a tax rebellion over a sin tax. She did not have the wealth to enter a European war. Besides, the Americans were supported by the monarch (King Louis XVI) the French were overthrowing. Which complicated matters.

Washington and Hamilton saw things differently than Jefferson. More like realists than the idealist Jefferson. The Revolution was over. The British and Americans were no longer enemies. But important trade partners. That shared a common British past. Of laws and traditions firmly established in what was once British America. So Washington issued his Proclamation of Neutrality (1793). They would support neither in this European war. Which infuriated the French. And Jefferson. For though they were neutral it was clear that their neutrality would favor the British. As well as Hamilton. And it did. But it also favored America’s best interests. For another long war would have probably bankrupted the nation. And perhaps resulted with her partitioned among the European nations. For the French Revolution lasted for a decade. And the Napoleonic Wars it begot lasted another 11 years. Which let us not forget the French lost. In large part due to the Royal Navy. And Great Britain’s wealth generated by her international trade. Something the Americans could not have altered had she entered the war on France’s side. A wise foreign policy call by President Washington (and yet another time he saved his country). But it was one that tore his administration apart. Firmly establishing the opposition party. With Jefferson at its head. With but one purpose. To destroy Hamilton. And to lead the nation away from where Hamilton was taking it.

Politics 101

In 1792 the Outstanding Debt at all Levels of Government was 45% of GDP

Wars aren’t cheap. Especially if they last awhile. The American Revolutionary War lasted some 8 years until the British and Americans signed the Treaty of Paris (1782) officially ending all hostilities. So the Revolutionary War was a very costly war. The ‘national’ government (the Continental Congress) owed about $70 million. The states owed another $25 million or so. And the Continental Army had issued about $7 million in IOUs during the war. Added up that comes to $102 million the new nation owed. About 45% of GDP. (Or about 35% without the state debt added in.)

To put that in perspective consider that the Civil War raised the debt to about 32% of GDP. World War I raised it to about 35%. World War II raised it to about 122%. Following the war the debt fell to about 32% at its lowest point until it started rising again. And quickly. In large part due to the cost of the Vietnam War and LBJ’s Great Society. Government spending being so great Nixon turned to printing money. Depreciating the dollar’s purchasing power in every commodity but one. Gold. Which was pegged at $35/ounce. Losing faith in our currency foreign governments traded their U.S. dollars for gold. Until Nixon decoupled the dollar from gold in 1971. Ushering in the era of Keynesian economics, deficit spending and growing national debts. Because of increased spending for social programs governments everywhere now have debts approaching 100% of GDP. And higher. But I digress.

So 45% of GDP was huge in 1792. And it continued to be huge. Taking a devastating civil war and a devastating world war to even approach it. It took an even more devastating world war to exceed it. And now we’ve blown by that debt level in the era of Keynesian economics. Without the devastation of another World War II. This debt level has grown so great that for the first time ever in U.S. history Standard and Poor’s recently lowered the United States’ impeccable sovereign debt rating. And restoring that debt rating at today’s spending levels will be a daunting task. But imagine trying to establish a sovereign debt rating after just becoming a nation. Already with a massive debt of 45% of GDP.

In Hamilton’s Report on Public Credit the New Government would Assume Outstanding Debt at all Levels of Government

There was only one choice for America’s first president. The indispensible one. George Washington. Some delegates at the Philadelphia Convention in 1787 who were skeptical of the new Constitution only supported it because they had someone they could trust to be America’s first president. George Washington. Benjamin Franklin, John Adams, Thomas Jefferson and James Madison were indispensible at times. But not as indispensible as Washington. For without him the Continental Army would have ceased to exist after that winter at Valley Forge. That same army would have mutinied (for back pay and promised pensions) after the war if he didn’t step in. Our experiment in self-government would have ended if he did not relinquish his power after the war. We wouldn’t have ratified the Constitution without having Washington to be America’s first president. And our experiment in self-government would have ended if he did not relinquish his power. Again. After his second term as president.

With the state of the government’s finances after the war there was another Founding Father that was indispensible. Not as indispensible as Washington. But close. For without him the Washington presidency may have failed. As well as the new nation. Because of that convoluted financial mess. The Continental Congress borrowed money. The states borrowed money. Some of which went to the Continental Congress. The army took stuff they needed to survive in exchange for IOUs. There were bonds, loans and IOUs at every level of government in every state. Complicating the matter is that most of the instruments they sold ended up in the hands of speculators who bought them for pennies on the dollar. As the original holders of these instruments needed money. And did not believe the Continental Congress would honor any of these obligations. For before the Constitution the government was weak and had no taxing authority. And no way to raise the funds to redeem these debt obligations.

A few tried to get their arms around this financial mess. But couldn’t. It was too great a task. Until America’s first secretary of the treasury came along. Alexander Hamilton. Who could bring order to the chaos. As well as fund the new federal government. He submitted his plan in his Report on Public Credit (January 1790). And the big thing in it was assumption. The federal government would assume outstanding debt at all levels of government. Including those IOUs. At face value. One hundred pennies on the dollar. To whoever held these instruments. Regardless of who bought them first. “Unfair!” some said. But what else could they do? This was the 1700s. There weren’t detailed computer records of bondholders. Besides, this was a nation that, like the British, protected property rights. These speculators took a risk buying these instruments. Even if at pennies on the dollar. They bought them for a price the seller thought was fair or else they wouldn’t have sold them. So these bonds were now the property of the speculators.

Jefferson and Madison traded Hamilton’s Assumption for the Nation’s Capital

Of course to do this you needed money. Which Hamilton wanted to raise by issuing new bonds. To retire the old. And to service the new. Thus establishing good credit. In fact, he wanted a permanent national debt. For he said, “A national debt, if not excessive, is a national blessing.” Because good credit would allow a nation to borrow money for economic expansion. And it would tie the people with the money to the government. Where the risk of a government default would harm both the nation and their creditors. Making their interests one and the same.

That’s not how Thomas Jefferson saw it, though. He had just returned from France where he witnessed the beginning of the French Revolution. Brought upon by a crushing national debt. And he didn’t want to tie the people with the money to the government. For when they do they tend to exert influence over the government. But Hamilton said debt was a blessing if not excessive. He did not believe in excessive government debt. And he wanted to pay that debt off. As his plan called for a sinking fund to retire that debt. Still, the Jefferson and Hamilton feud began here. For Hamilton’s vision of the new federal government was just too big. And too British. Madison would join Jefferson to lead an opposition party. Primarily in opposition to anything Hamilton. Who used the Constitution to support his other plan. A national bank. Just like the British had. Based on the “necessary and proper” clause in Article I, Section 8. Setting a precedent that government would use again and again to expand its powers.

At the time the nation’s capital was temporarily in New York. A final home for it, though, was a contentious issue. Everyone wanted it in their state so they could greatly influence the national government. Hamilton’s struggle for assumption was getting nowhere. Until the horse-trading at the Jefferson dinner party with Hamilton and Madison. To get the nation’s capital close to Virginia (where it is now) Jefferson offered a deal to Hamilton. Jefferson and Madison were Virginians. Give them the capital and they would help pass assumption. They all agreed to the deal (though Jefferson would later regret it). Congress passed the Residency Act putting the capital on the Potomac. And all the good that Hamilton promised happened. America established good credit. Allowing it to borrow money at home and abroad. And a decade of prosperity followed. Hamilton even paid down the federal debt to about 17.5% of GDP near the end of America’s second president’s (John Adams) term in office (1800). Making Hamilton indispensible in sustaining this experiment in self-government. Keeping government small even though it was more powerful than it was ever before. Of course his using that “necessary and proper” argument really came back to bite him in the ass. Figuratively, of course. As government used it time and again to expand its role into areas even Hamilton would have fought to prevent. While Jefferson no doubt would have said with haughty contempt, “I told you so. This is what happens when you bring money and government together. But would you listen to me? No. How I hate you, Mr. Hamilton.”

Thomas Jefferson hated Alexander Hamilton. For a variety of reasons. He thought he was too cozy with the British. And too anti-French. He also thought Hamilton was too cozy with the merchant class and bankers. Jefferson hated them, too. For he thought honest Americans farmed. Not buy and sell things other people made. Or loaned money.

But Hamilton was not a bad guy. And he was right. George Washington, too. America’s future was tied to the British. Trade within their empire benefited the fledging American economy. And the Royal Navy protected that trade. For they ruled the seas. They couldn’t get that from France. Especially with a France waging war against everyone.

But there was something especially that Jefferson hated Hamilton for. Assumption. And funding. The new nation’s finances were a mess. No one could figure them out. There was pre-war debt. And war debt. State debt. And national debt. The Americans owed their allies. Neutral nations. And the former enemy they just won their independence from. Getting their hands around what they owed was difficult. But important. Because they needed to borrow more. And without getting their finances in order, that wasn’t going to happen.

Thomas Jefferson Understood that a Permanent Debt gave a Government Power

Hamilton was good with numbers. And he put America’s financial house in order. A little too well for Jefferson. The new federal government assumed the states’ debts (assumption). And serviced it (funding). Giving great money and power to the federal government. Far more than Jefferson believed the Constitution granted. And this really stuck in his craw. Because this was the source of all the mischief in the Old World. Money and power. The Old World capitals were both the seats of political power. And the centers of commerce and banking.

Jefferson understood that a permanent debt gave a government a lot of power. Because debt had to be serviced. And you serviced debt with taxes. The bigger the debt the greater the taxes. Which didn’t sit well with this revolutionary. I mean, excessive taxation was the cause for rebellion. Taxes are bad. And lead to political corruption. Because the more taxes the government collects the more it can spend on political favors. Patronage (good paying government jobs for political allies). Giving rise to a politically-connected ruling class. Like the Old World aristocracies. Government grows. As does their control over the private sector economy.

It’s a process that once started moves in only one direction. Greater and greater debts. Paid for by greater and greater taxes. Until the debt becomes unsustainable. Like in Revolutionary France. In present day Greece. And even in the United States. Who, in 2011, saw its sovereign debt rating downgraded for the first time in American history. Because of record deficits. And record debt. Caused by excessive spending. Everything that Jefferson feared would happen. If government had a permanent debt.

Baseline Budgeting guarantees Permanent Growth in Government Spending

Big Government spending took off in America in the Sixties. Historically government receipts averaged 17.8% of GDP. During the Fifties and the Sixties, GDP grew while debt remained flat. Of course, if GDP grew then so did tax dollars coming into Washington. For 17.8% of an expanding GDP produced an expanding pile of cash in the government’s coffers.

Liking the taste of this money, government kept spending. So much so that they adopted baseline budgeting in 1974. Where current spending is automatically added to for next year’s spending. Guaranteeing permanent growth in government spending. To pay for LBJ‘s Great Society. The Vietnam War. Apollo. And other spending programs. The spending was so out of control that the debt started to creep up. And what they didn’t borrow they printed. Leading to the Nixon Shock.

The Nixon Shock (ending the quasi gold standard) unleashed inflation. Which Paul Volcker and Ronald Reagan defeated. With inflation tamed and the Reagan tax cuts, the Eighties saw solid GDP growth. And record deficits. The Democrats liked all that cash coming into Washington. And they spent it faster than it came in. But to reduce the deficit they made a deal. For each dollar in new taxes the Democrats would cut three dollars in spending. Of course they lied. Because Democrats don’t cut taxes. They got their new taxes. But Reagan didn’t get any spending cuts. In fact, the deal went the other way. For every dollar in new taxes there were three dollars in new spending. The deficit grew bigger. And for the first time the debt grew at a greater rate than GDP. As shown here:

After the 1994 midterm elections, Bill Clinton and the new Republican House compromised. They reined in spending. Implemented welfare reform. And rode the dot-com bubble on the good side. Before it burst. It was capital gains galore. Put all of this together and GDP rose and flooded Washington with tax receipts. While debt remained flat. In fact, there were budget surpluses forecast. But then that dot-com bubble burst.

It was an $800 billion stimulus. Something he promised would have no pork or earmarks. Nothing but shovel-ready projects. Of course, it was nothing but pork and earmarks. And those shovel-ready projects? There’s no such thing. So the stimulus didn’t stimulate anything. Other than record deficits (surpassing Bush’s). And record debt. Debt increasing at a greater rate than GDP. And equal to or greater than GDP in dollars. Not seen since World War II.

Hamilton and Jefferson would have United in Opposition against Barack Obama

Debt fell as a percentage of GDP following World War II. It fell from above 90% to below 40% around the end of the Sixties. GDP was rising during this period while debt remained flat. So the flat debt became a smaller and smaller percentage of a growing GDP. The ‘growing your way out of debt’ phenomenon. But that process stopped and reversed itself during the Seventies. When Congress spent with a fury. As noted above. Debt grew. Back to the level of GDP it was during a world war. Only now there is no world war. And we’re not spending to save democracy. We’re spending to end democracy.

It is what Jefferson feared most. Out of control government spending. Racking up massive debt. The kind that is impossible to pay off. And is permanent. And it was being done not for a war to save democracy from fascism. But to change America. To make it a different kind of nation. No longer one of limited government. But Big Government. One with a ruling class. A ruling class that now has a claim on 100% of GDP. To pay for everything they gave us. Where there is no choice but fair-share sacrifice. Where everyone pays their ‘fair share’ of taxes. Which is government-speak for raising taxes on everyone. To flood government coffers with more private sector wealth.

The country is not what it was. And it will never be what it once was again. Not with this level of spending. This is the kind of spending nations see in their decline. It’s what toppled Louis XVI. It’s what roiled Greece in riots. It’s what downgraded U.S. sovereign debt. For the first time. Even Alexander Hamilton wouldn’t approve of this. For his Big Government idea was all about making the nation an economic superpower. Not bringing back feudalism.

So if you’re not a fan of Barack Obama, here’s something you can credit him for. His policies would have reconciled two of our most beloved Founding Fathers. For Hamilton and Jefferson may have hated each other. But they would have united in opposition against Barack Obama.